Should the host economy invest in a new industry? The roles of FDI spillovers, development level, and heterogeneity of firms.

We consider a small open economy with two productive sectors (an old and a new). There are two types of firms in the new industry: a well planted multinational firm and a potential domestic firm. Our framework highlights a number of results. First, in a poor country with low return of training and weak FDI spillovers, the domestic firm does not exist in the new industry requiring a high fixed cost. Second, once the host economy has the capacity to create the new firm, the productivity of the domestic firm is the key factor allowing it to enter into the new industry, and even eliminate the multinational firm. Interestingly, in some cases where FDI spillovers are strong, the country should invest in the new industry, but not train specific workers. Last, credit constraints and labor/capital shares play important roles in the competition between the multinational firm and the domestic one.